When you think about your retirement, the last thing you’re going to want to worry about is money – you want to have a good time, do all the things you’ve not had time to do before, and just enjoy life. But for many people who retire, managing finances can get tricky – after all, your income is often fixed, yet life keeps throwing unexpected expenses your way (it always does).
One option that some retirees are looking into more is tapping into the equity in their homes using a Home Equity Line of Credit (HELOC). A HELOC in retirement can be a fantastic idea, offering plenty of financial flexibility and liquidity when you need it most. Of course, like any financial options for anything at all in life, there are some risks, but it could be an ideal thing to do, depending on your needs and individual circumstances. With that in mind, keep reading to find out more about a HELOC in retirement, the benefits it can offer, and the potential pitfalls you could come across, and in that way, you’ll know whether it’s something you should explore further.
What Is A HELOC?
Let’s look more closely into precisely what a HELOC is because knowing the basic facts is the first step in helping you decide whether or not this could be the right step for you in your retirement. Essentially, a HELOC is a revolving line of credit that lets you borrow against the equity of your home – and equity, in case you didn’t know, is just the difference between your home’s current value and what you still owe on the mortgage.
As you pay down your mortgage over the years (or as the value of your home increases – and ideally both of these things will be happening at the same time), your equity grows more and more, and that’s where the HELOC in retirement could come into play if you want it to and if it’s something that’s going to be beneficial.
Here’s how it works:
- The Draw Period
The draw period is the first part of the HELOC, and it usually lasts between five and 10 years, depending on what you agree to and what your advisor suggests. During this time, you can borrow as much money as you want and need up to your credit limit (which is going to be based on your home’s equity, as we said). Now that’s a handy thing to be able to do, and there’s a massive perk to this too; you only have to pay interest on the amount you borrow during the draw period (rather than the principal), and it’s this kind of flexibility that makes HELOC so attractive to so many people – particularly people who are about to or already have retired.
- The Repayment Period
You’ll notice the draw period has a timeframe connected to it, and once that’s over, you’ll enter the repayment period. At that point, you won’t be able to borrow any more money from the HELOC, and you’ll need to start paying both the interest and the principal back. As for a timeframe here, you’re probably looking at anywhere between 10 and 20 years, again depending on your circumstances and what you signed up for.
The really big positive about a HELOC in retirement is that it allows you to enjoy your home’s value without you having to sell it, so you can look at it as being the best of both worlds – but there are risks and downsides, and it’s crucial to know about them before you make any kind of decision, especially a financial one. Let’s take a look at both sides now so you can see what could work and what wouldn’t.
The Benefits of HELOC in Retirement
Let’s start with the good stuff, and the great news is that there’s plenty of it. For many retirees, a HELOC can give them much-needed financial flexibility during a time when income might be limited, so here’s some reasons why a HELOC in retirement could be a smart move.
Financial Flexibility
Perhaps the biggest advantage of a HELOC in retirement is the flexibility it gives you – it’s not like a traditional loan where you borrow a lump sum and start repaying it right away because a HELOC allows you to borrow just what you need, and to borrow it when you need it. That can be so useful in retirement when there’s unexpected expenses like medical bills, home repairs, or even a dream vacation – these costs can pop up out of nowhere, and having the money to deal with them right away is a big weight off anyone’s shoulders.
The beauty of a HELOC is that you can use it for all kinds of different expenses, whether it’s to cover medical bills, fund a trip, pay for a grandchild’s education, or just to have a bit of a buffer of ‘just in case’ money. In other words, with a HELOC in retirement, you don’t have to think about running out of money and can just enjoy your plans to the fullest.
Low Interest Rates
One of the (many) reasons a HELOC in retirement is such a popular option is the relatively low interest rates it offers. The fact is that high interest rates aren’t needed because your home acts as collateral, so lenders are willing to offer much lower rates compared to what you’d get with a credit card or a personal loan. That makes a HELOC a much more cost-effective way to borrow, especially for retirees who might not want to (or be able to) take on high-interest debt.
Right now, the money you use a HELOC for might even be tax deductible, although that’s going to depend on what you use it for (home improvements are a good example of when it is), so there’s another potential cost-saver for you. The best thing to do is speak to an expert about all the implications, including taxes, just so you’ve got a good idea of the ins and outs before you decide to go ahead (or not) with a HELOC in retirement.
Access to Large Sums of Money
If you’ve been paying off your home for years, chances are you’ve built up a good amount of equity, so a HELOC in retirement could mean you’ve got access to a large sum of money when you want it to make home modifications for seniors – and you don’t have to sell your home to get it either! Of course, you might want to downsize for all kinds of reasons, but it’s good to have the choice not to – many people move home in retirement not because they particularly want to live somewhere else, but because they can then enjoy the equity they’ve built up. So why go through the hassle of moving and leaving all those memories behind if you don’t have to?
No Immediate Repayment
During the draw period of the HELOC, you only have to pay interest on the money you borrow – that’s a huge bonus for retirees, who might have limited cash flow (hence the need for a HELOC in retirement in the first place) and who don’t want to pay massive repayments every month. Being able to defer the principal repayment during the draw period can free up cash for other things, and give you plenty of breathing room in your retirement budget.
If you’re not sure what we mean, here’s an example. Let’s say you’re on a fixed income from Social Security and a pension, but you need some extra cash to cover some medical bills (it’s a likely scenario). A HELOC in retirement means you can borrow that money and make smaller, interest-only payments, which means you’ve got a lot of flexibility with your monthly budget. Of course, once the repayment period begins you’ll need to start repaying the principal as well, so you’ll need to plan ahead for that, but in the meantime, you can get everything done that needs to be done without any worries.
The Risks of HELOC in Retirement
As you can see, there are plenty of excellent benefits and amazing reasons to go ahead with a HELOC in retirement, but there are some negatives as well, and it’s crucial to understand them so you can make the right choice – a HELOC isn’t for everyone.
Risk of Losing Your Home
Now this is a big one, and possibly the most problematic of the issues that come with a HELOC. The fact is that no matter how you look at it, you’re borrowing money against your home, which means that if you can’t make repayments (either during the draw period or the repayment period) – your lender could foreclose on your home. That’s a big concern and a potential risk that retirees really do need to think about, especially if your income stream really is limited and paying the money back is going to be a stretch. A HELOC in retirement is meant to make things easier, not harder, so if it’s going to be a struggle, it’s not worth doing.
Remember that in the draw period you’ll need to make small repayments to cover the interest, and that might be manageable, but that draw period will end, and then you’ll need to pay back the rest of the loan, and the repayments are going to rise – if you’re not prepared for that jump in monthly repayments, you could find yourself in a difficult financial situation.
That’s why it’s so important to have a clear repayment plan in place before taking out a HELOC in retirement – make sure you understand the terms of the loan, how much your repayments will be, and whether you’re going to have enough money to cover it.
Variable Interest Rates
We’ve said that HELOCs often come with lower (compared to other forms of borrowing) interest rates, but what we’ve not yet mentioned is that those interest rates are variable – they can go up or down depending on the economy and other factors, and that means you might not be quite sure how much you’ll be paying each month. And if interest rates rise, that could mean what was a comfortable repayment amount starts to become much more of a problem.
To get over this potential problem, it’s possible to convert your HELOC into a fixed-rate loan once the interest starts to rise, but although that’s going to give you more stability, the interest rate that comes with it might be higher than the HELOC rate, so you’ll need to weigh up the pros and cons of making the switch and do some in-depth research, as you’ve got to make sure it’s not going to cause you any financial issues.
Reduced Equity for the Future
When you use a HELOC in retirement, you’re tapping into the equity in your home – that’s how it works. But although you’re going to get access to money, you’re also going to reduce the equity amount in general, so if you do decide to sell your home to downsize (or to pay off the loan), you’ll make less of a profit. That could limit what you’re able to do and even what property you’re able to buy, especially if you’re not eligible for a mortgage to top things up.
That’s why it’s so important to think about how a HELOC in retirement is going to fit into your long-term plans (and, in fact, why it’s important to have long-term plans in the first place; you can’t make decisions about your future if you don’t know what that future looks like or what it’s going to cost).
Repayment Can Be Challenging
As we mentioned earlier, the draw period of a HELOC in retirement offers a lot of flexibility, with interest-only payments that are often manageable on a fixed income like you’ll probably have in retirement. However, once the repayment part of the HELOC kicks in, you’ll need to start repaying the whole amount, and these repayments can be big ones, especially if you borrowed a lot of equity.
If you’ve not planned ahead for this part, suddenly having to pay back a big loan can be a huge strain and it’s possible you might default on the loan and your home could be repossessed as a result. That’s stressful and miserable and something you’ll want to avoid, which is why deciding on whether or not to take on a HELOC in retirement should never be a split moment decision – there’s a lot of thinking to do.
Why Is a HELOC in Retirement a Good Idea?
You’ve seen the pros and cons, and it should be clear that a HELOC in retirement is a great option for some people, but it’s not a one-size-fits-all kind of solution, so with that in mind, here are a few situations when a HELOC makes a lot of sense.
- If you need short-term access to funds because you’re facing a temporary cash flow issue or you need to pay for a large expense, a HELOC could be the best option. You’ll get financial flexibility but you don’t have to be locked into a long-term loan, so it’s got you covered.
- Before you take out a HELOC, you’ll need to make sure you’ve got a solid repayment plan in place – one that you really can follow and keep up with. Even if the interest payments are easy enough to deal with, not planning for the main repayment part of the HELOC is a big error. If you’ve got a plan you’re happy with then borrowing this way makes sense.
- Another reason to take out a HELOC is if you’ve got a substantial amount of equity in your home and you don’t plan to sell it any time soon. By tapping into that equity through a HELOC, you can get access to lots of cash without losing any assets.
When Should You Avoid a HELOC in Retirement?
As we’ve said, a HELOC isn’t the right call for everyone, and here are some examples of when you should avoid taking one out.
- If your income is uncertain and you’re not confident in your ability to make repayments during the repayment period it’s probably not a wise idea to take on a HELOC in retirement. The risk of foreclosure is a big gamble to take if you can’t be one hundred percent certain about things.
- Perhaps you’ve got other options like savings, investments, or retirement accounts, and if so, it’s worth considering them before tapping into the equity in your home. The truth is that a HELOC should be a last resort, not the first thing you think of.
- If you’re planning to downsize in the future, taking out a HELOC is just going to mean your home is worth less, which limits your options.
Is a HELOC in Retirement Right For You?
A HELOC in retirement can offer a flexible way to access funds, give retirees the breathing room they need, and basically make retirement more enjoyable. However, it definitely comes with risks, and it’s vital to go through all the pros and cons (which include interest rates, repayment terms, and your long-term financial plans) before you make any kind of decision.
The best thing to do if you’re thinking about a HELOC in retirement and want to know more is to speak to an expert who can guide you through the process and advise you on the right path to take.